Building Towards Your Magic Number Brick by Brick

Sorry everyone, between conference week and family commitments (some expected, some…less expected),  I haven’t posted at all in the past 2-3 weeks.

My apologies for that.

I hope you can forgive me

Anyway…here we go…once again…

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

Portfolio Building

As we continue moving forward, we will eventually explore how to evaluate individual stocks and funds which suit your needs/fit your goals.

First, however, we will think larger and discuss how an entire portfolio would/should be constructed before detailing its individual components.

A key element—possibly THE key element—of your investment portfolio is knowing what your goals are. How much money do you want/need and by what time do you want/need it coupled with what your risk tolerance will allow for. Unfortunately, sometimes, these factors are contrary to one another and thus require calibration of one of these three variables: money, time, or risk tolerance.

You cannot reliably construct an investment portfolio until you answer these questions frankly and honestly.

In other words, your portfolio is built from starting at the end and then working backwards to the present day.

If you’re not thinking of it that way, you’re doing this all wrong.    

If you have a financial advisor, he or she should be sitting you and/or your family down to understand your income level, how big your family is, how big it might become, what your hopes and goals are, do you hope for an extra car or a vacation home or any other luxury item, etc. And once that initial interview is done, it needs updated—ideally yearly and on a PRN basis if circumstances about your job, family, etc change significantly. If your financial advisor is not doing that, then you need another financial advisor.

Let’s assume that you’re married or will be with 1-3 children that will go to college which you will pay for (Oh, great), own one house without any second ones (vacation or otherwise), and no significant luxury items (boats, high end cars [Bentleys, Maseratis, not Mercedes or BMWs], etc).The last assumption to be made (dangerous I know) is that you/your spouse have a moderately high risk tolerance (ie, willing to take short term losses for better long term gains in your younger days and middle age, but then increasingly conservative as you get older/closer to retirement).  

This profile would put you and/or family in the vast majority of people saving for retirement. (Obviously, the more different your profile is, the more impact it may have on your investment style and portfolio.)

So, let’s get started with the standard portfolio for the “average” person/family.

There’s a rule of thumb floating around out there on how you should be adjusting your portfolio over time as you age.

110-age=% of your portfolio that should be in stocks+funds combined

The remainder is supposed to be in bonds.

SR: Here we go with the math again…

So, even at age 50, you’d have 60% of your portfolio in stocks with 40% of your portfolio in bonds.

SR: This kid is pretty quick with the math!

And, then, assuming (there’s that word again) this portfolio will continue to morph with advancing age to the point where at age 70 there will still be 40% stocks/funds, Some would argue that it’s too aggressive at such an age. The counterargument is that it balances out a too conservative approach in your 40’s-60’s ( at least for some like myself, but as I have stated before I am an aggressive investor with a very high risk tolerance which is not at all advisable for everyone and shouldn’t be followed as a template) and also ensures some good ongoing returns as you age since you really don’t know how long your retirement nest egg will need to last even starting at age 70.

A piece of advice:

Make sure your money last between 90-95 years old. If it lasts that long, then you’re set. If you…gulp…die before your money runs out (AKA the Dream scenario), then you can set up that the remaining money passes on to your children, grandchildren, or even favorite charity—or some combination thereof. You won’t regret it; you will have regrets if you do run out of money. Living off your kids for basics like food and shelter in your advanced age is not a good look and will only cause conflict (if not hell on Earth) for your…and especially your spouse…which is far worse than for you.

BACK TO THE PORTFOLIO…

There will be costs to you re-calibrating your investment portfolio yearly in terms of capital gains (hopefully!) especially, so reconfiguring it only every five-ten years makes far more sense than it does to do it annually. Of course, it may not involve selling one security to buy another, but rather re-allocating the proportion of new purchases to tilt your portfolio the way it is supposed to go. If you’re really lucky, this may be difficult if your stocks/funds with dividends are accumulating value so quickly or so highly that you will have a higher proportion of stocks/funds that you intended to have.

As my grandfather used to say, this is a first class problem.

If you have this all mapped out with your financial advisor, then it will be done for you in what should be the most tax efficient way possible. But, please, please, whatever you do—don’t put it into auto pilot. You need to meet with your financial advisor AT LEAST yearly—ideally, quarterly—to review how your portfolio is doing and that the plan you set forth years (decades?) ago still makes sense.

Another option is Target Date Funds.

It’s a fund that has a mix of stocks, mutual funds, and bonds that will go from little bonds to much bonds with stocks/funds decreasing in parallel. There is a year in the title of the fund that should signal to you as an investor that the stated year (Vanguard Target Retirement 2045 for example) is the year you are retiring. All the work and re-calibration is done for you for a small (hopefully) expense ratio.

Target date funds definitely underperform the S&P 500, but they should given that they have some bonds in them (as well as funds with their own expense ratios that can drag performance as well). That’s the whole point. Unspectacular, but solid is the goal with target date funds here. These funds are supposed to bring solid returns over decades to give you a comfortable retirement.

Baseball analogy for target date funds: Singles and doubles, not home runs (which will always inevitably bring about a higher strikeout rate with it as well)

If you want higher returns than say 6.8% over the past decade, (don’t forget subtracting the expense ratio from the returns over that past decade for all of you who clicked on the link and said, this loser doesn’t know what’s up and underestimated returns) then you’ll have to go a different route…or…a hybrid method.

But, that’s a different story for a different post.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…